Money Market Funds
Operations and Technology
PCAOB Must Demonstrate Need for Mandatory Audit Firm Rotation
By Amy Lancellotta and Gregory Smith
December 22, 2011
The Independent Directors Council (IDC) and the Investment Company Institute (ICI) oppose requiring a mandatory rotation of audit firms as detailed in a concept release from the Public Company Accounting Oversight Board (PCAOB). As our comment letters point out, the PCAOB has not clearly connected audit deficiencies discovered through its inspections of audits to a lack of auditor independence. Further, the PCAOB has failed to demonstrate any audit deficiencies specific to audits of investment companies.
With its concept release, the PCAOB is seeking ways to improve auditor independence, objectivity, and professional skepticism. According to the Board, limiting the number of consecutive years for which a registered public accounting firm could serve as the auditor of a public company—including a fund—may help avoid relationships between auditors and management that protect long-term relationships to the detriment of investors. The Board also believes mandatory audit firm rotation can create incentives for auditors to perform more-rigorous audits because they know that the successor auditor will scrutinize their work. Such an arrangement also enables the successor auditor to take a “fresh look” at the company’s financial reporting.
We agree that the integrity of the audit process depends on independent and expert auditors, but an audit firm rotation requirement is not necessary to achieve this goal and, in fact, could detract from it. Existing safeguards and recent enhancements to auditing standards are more than adequate to assure the independence of auditors. Indeed, we believe public company audits have improved significantly since the Sarbanes-Oxley Act of 2002 and its audit-related reforms.
A mandatory audit firm rotation could increase costs. The successor auditor would necessarily have to build additional hours during the first years of its tenure in order to become familiar with the client’s business, systems, and control environment. These additional hours could result in increased audit fees, which would be borne by fund shareholders. If the PCAOB’s proposal were implemented, a study estimated that initial year audit costs would increase by more than 20 percent over subsequent year costs.
Ironically, audit firm rotation could even increase the risk that the auditor will fail to detect errors or misstatements. The loss of institutional knowledge the incumbent auditor brings to the engagement, combined with a steep learning curve that the successor auditor must climb, may increase audit risk.
Our concerns about mandatory audit firm rotation are heightened in the fund context because of the limited number of audit firms that are qualified—in terms of expertise and independence—to audit fund financial statements. Auditing fund financial statements requires specialized industry and regulatory expertise. Only a limited number of audit firms currently possess this expertise. In addition, the universe of independent auditors able to satisfy the auditor independence requirements is made even smaller by factors specific to the fund industry, such as the broad definition of “investment company complex” and the use of funds offered through an audit firm’s 401(k) retirement plan to its employees.
Mandatory audit firm rotation would also undermine the authority and discretion of fund boards and their audit committees. As IDC explained, the Investment Company Act of 1940 (1940 Act) has long required independent directors to select a fund’s auditor. Indeed, picking an audit firm is one of only four responsibilities that the 1940 Act specifically assigns to independent directors—a clear measure of the importance of the audit function and the role of fund independent directors. This statutory approach has worked well, and the PCAOB should not infringe on its success. Determining whether to retain the fund’s current auditor is best left to the judgment of a fund’s independent directors, who work diligently to oversee fund audits and make determinations that are in the best interest of the fund and its shareholders.
We support the PCAOB’s mission to oversee the audits of public companies—including funds—to protect the interests of investors. In this concept release, however, the PCAOB fails to demonstrate how mandatory audit firm rotation would support that mission.
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Amy Lancellotta is Managing Director of the Independent Directors Council. Gregory Smith is Director of Operations, Compliance, and Fund Accounting for ICI.
ICI Adds to Educational Resources on Exchange-Traded Funds
By Mike McNamee
December 16, 2011
ICI Adds to Educational Resources on Exchange-Traded Funds.
TOPICS: Exchange-Traded Funds
Money Market Funds Continued to Reduce Eurozone Holdings in November
By Sean Collins and Chris Plantier
December 16, 2011
Over the last year, U.S. money market funds have significantly reduced their holdings of debt securities issued by banks and other businesses headquartered in the 17 countries that use the euro as their currency. That trend continued in November.
Time to Stamp Out the Confusion Around ‘Shadow Banking’
By Brian Reid
December 6, 2011
In the United States, money market funds are governed by tight risk-limiting rules, rules that have become considerably tighter since 2008. The Securities and Exchange Commission (SEC) has indicated further changes are forthcoming.
Yet some recent commentary and reporting on money market funds misses this fact, substituting instead the vague notion that these funds lurk in a seemingly unregulated world of “shadow banking,” an epithet used to debase a large group of nonbank financial intermediaries and activities. A recent Wall Street Journal column, for example, characterized money market funds as “one of the riskiest participants in shadow banking.” Last May, a Reuters story described shadow banking as “a network of loosely regulated private equity, hedge, and money funds that together are large enough to topple the global financial system.”
Funds' Board Structures Promote Efficiencies and Cost Savings for Shareholders
By Amy Lancellotta
December 5, 2011
Reporters, academics, and others who are unfamiliar with investment companies sometimes question the unusual structure of fund boards. Unlike operating companies—where each company as a rule is overseen by its own board—multiple funds in a complex typically share common boards. In Overview of Fund Governance Practices, 1994-2010, we found that 83 percent of fund complexes use a “unitary board” (one board for all their funds), while 17 percent use “cluster boards” (two or more boards, each overseeing a group of funds within the complex).
TOPICS: Fund Governance
Data Update: Money Market Funds and the Eurozone Debt Crisis
By Sean Collins and Chris Plantier
December 2, 2011
In October, we discussed how portfolio managers of U.S. prime money market funds have addressed the ongoing debt crisis in the eurozone. Here is a look at the latest monthly data on these funds’ holdings by home country of issuer. We will revisit the topic in mid-December with updated analysis once November figures become available.